Are we there yet? Striving for a corporate bond market

The well-known brands have always been able to raise debt locally. The real test is how often they are prepared to return and whether the local market will invest in less well-known and lower-rated companies on terms that compete with overseas markets.
Illustration: Karl Hilzinger

It’s a question that’s been asked for as long as anyone can recall: what will it take to give Australia a competitive debt market to reduce our corporate reliance on banks and offshore markets?

The search for the answer has become more urgent since the GFC, as many local companies were left with only bank debt during the crisis.

Since then, however, offshore debt has been so cheap that some companies have been able to fund at lower rates overseas than the big four banks – even make money on such issues by depositing the proceeds in term deposits.

There are signs, however, that the interests of issuers and investors have finally aligned in Australia.

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The evidence of change began a year ago with big name brands hitting the local debt market after many years of absence, including
BHP Billiton
raising $1 billion via a five-year bond in October 2012 and
Qantas
raising $125 million over seven years in May 2013. Both companies hadn’t issued in Australia for a decade.

Coca-Cola Amatil
– one of those that has made money on offshore debt issues, with about $1 billion banked from these to pre-fund maturing debt – also returned to the local market in November for the first time since 2006.

But the well-known brands have always been able to raise debt locally. The real test is how often they are prepared to return and whether the local market will invest in less well-known and lower-rated companies on terms that compete with overseas markets.

This is happening now, but it is uncertain whether it is coincidence or the start of something more sustained.

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While the total value of issuance by non-financial corporations is at similar levels to this time in 2012 on around $6 billion, it has maintained that level at the same time as total issuance by Australian corporations is tracking lower. Non-financial companies here raised $58 billion of debt on capital markets worldwide in 2012, compared to $24.3 billion so far in 2013.

The most important change is that more BBB-rated companies are now getting a look in to the local market and investors are prepared to lend over longer terms.

Debt raisings in the Australian medium term note market by BBB rated companies have so far nearly doubled to 29 per cent in 2013 compared to 2012 .

While five-year tenors accounted for 37 per cent of the debt issued in 2011 and 53 per cent in 2012, seven-year terms jumped from just 4 per cent in 2011 to 19 per cent in 2012 and 39 per cent so far in 2013. Even 10-year issues are beginning to make a showing, with 4 per cent falling into this category this year.

Fertiliser and explosives manufacturer
Incitec Pivot
has long raised large amounts of debt offshore to fund its US dollar interests, but also its Australian operations. This has included several forays into the 144A market in the US in recent years, as well as the US private placement market.

However, in August it tapped the local market for the first time to raise $200 million at 5.75 per cent over five years. Treasurer
Geoff McMurray
said the company issued locally for several reasons. It didn’t need the minimum $500 million and 10-year tenor usually favoured on the 144A, and its US dollar needs had been fulfilled.

A second-order desire was diversifying Incitec’s funding sources.

He said the local market is more competitive now. One reason is regulatory and accounting rule changes kicking in this year that have increased the costs of swapping back US dollars into Australian dollars. “In addition, the low-interest-rate environment, both offshore and locally, seems to be encouraging Australian investors to move down the credit curve in search of higher yields. This has opened the Australian bond market to BBB issuers who have been shunned by the local market in the past," he said.

Coca-Cola Amatil treasurer
Keith Allan
said they would always prefer to raise Australian dollars as much of their funding needs are in that currency and there is greater liquidity in the local market. But it was only late last year that the tenor and pricing, including swap costs, became competitive.

“Five to seven years is a lot better deal for many corporates who have boards focusing on refinancing risk post-GFC," he said. Before that they might have been happy doing three to five years, “now five to seven or longer is better".

Investors confirm the search for yield as interest rates have declined has driven them to accept lower returns for longer term debt.

Jeff Brunton
, head of credit markets at AMP Capital, told a roundtable discussion in Sydney in September they are keen to see a well-functioning local debt market. But while bank term deposits are less competitive now, he said investors have to be prepared to lend longer than five years to compete with banks’ corporate lending arms.

He thinks low interest rates could keep the market dynamics right to build more volume in the local debt market in the next couple of years, but the big opportunity now is to kick-start the retail debt market – and that still requires a cultural change among investors. “The issue we have is still a banking system that is too large relative to the fixed income markets," he said. “To really get change there we need to come back to activating retail and we don’t have a fixed income culture. We have an aging population and I think if we all are serious about having a vibrant domestic market that seems to be the logical next step."

Brad Scott
, head of corporate bond origination at NAB, says Asian investors – particularly private banks – have been another important driver of the local market. “There was a time when you would only see offshore participation in deals where there was a direct linkage to Asia," he said.

“Now, basically, Asian investors are looking to diversify out of the Asian region and look at Australia as a safe place. They are also chasing yield and they also like our legal and political structure in Australia and thus far we are seeing them chip in very heavily towards theses structures."

McMurray at Incitec is encouraged by the signs, but like several the Financial Review spoke to, he believes the local debt market will only prove its mettle when it has stayed open in good and bad economic times. “There are still lengthy periods where the local market effectively closes, with issuers often needing to wait several months until market conditions become favourable before issuing," he said.

“The Australian bond market would need to demonstrate consistent performance over several years and through various economic cycles before it could be considered to be deep, liquid and of high quality."